* Canadian dollar rises 0.7 percent against the greenback
* Loonie touches its strongest since Dec. 22 at 1.3470
* Canada's 10-year yield hits its lowest in more than 16 months
* Canada-U.S. 2-year spread narrows by 4.3 basis points
By Fergal Smith
TORONTO, Jan 3 (Reuters) - The Canadian dollar strengthened to a two-week high against its U.S. counterpart on Thursday, boosted by higher oil prices and a narrower gap between U.S. and Canadian interest rates.
The loonie's gains came ahead of the release on Friday of Canada's employment report for December, which could help guide expectations for next week's interest rate decision from the Bank of Canada.
Expectations of further interest rate increases have crumbled after the central bank said last month that it was worried about the impact on the economy of a sharp drop in oil prices since October. But expectations have also faded for further tightening from the U.S. Federal Reserve.
"The fade in Fed expectations is a bit more aggressive than the fade in Bank of Canada rate expectations," said Eric Theoret, a currency strategist at Scotiabank.
The gap between Canada's 2-year yield and its U.S. equivalent narrowed by 4.3 basis points to a spread of 61.8 basis points in favor of the U.S. bond, its narrowest since Nov. 28.
At 3:58 p.m. (2058 GMT), the Canadian dollar CAD=D4 was trading 0.7 percent higher at 1.3480 to the greenback, or 74.18 U.S. cents. The currency, which fell 7.8 percent in 2018, touched its strongest level since Dec. 20 at 1.3470.
The price of oil, one of Canada's major exports, rose in volatile trade, drawing support from signs that Saudi Arabia is cutting crude output. U.S. crude oil futures CLc1 settled 1.2 percent higher at $47.09 a barrel. U.S. dollar .DXY declined against a basket of major currencies as the yen surged. Investors were attracted to the perceived safety of the Japanese currency after a surprise revenue warning from Apple Inc AAPL.O exacerbated concerns about a Chinese and global economic slowdown. government bond prices were higher across the yield curve, with the two-year CA2YT=RR up 13 Canadian cents in price to yield 1.769 percent and the 10-year CA10YT=RR rising 64 Canadian cents in price to yield 1.828 percent.
The 10-year yield hit its lowest intraday level since August 2017 at 1.814 percent.